December 28, 2008

U.S. Ambassador to the Organization for Security and Cooperation in Europe (OSCE) Julie Finley recently told RFE/RL that Russia’s move to prevent the OSCE from extending the mandate of its mission in Georgia came as “a surprise” to her.

Similar sentiments were heard from many Western officials back in August, when Russia’s large-scale military intervention in Georgia seemed totally unexpected to them. A short time later, Moscow again took the West by surprise when — in violation of the UN Charter — it recognized the independence of the breakaway Georgian regions of South Ossetia and Abkhazia.

It seems that only Central and Eastern Europeans — as well as Georgia’s own leaders — have a good sense of what to expect from Vladimir Putin’s Russia. “Russia’s attack on Georgia was not unexpected,” Georgian President Mikheil Saakashvili told a conference in Riga in November at which international experts assessed how the international situation had been altered by the Russia-Georgia war.

Saakashvili’s counterparts from Poland and the Baltic states — educated by bitter historical experience — have long tried to persuade their Western allies that the world must be prepared for “unexpected” moves from the Kremlin.

But these warnings have largely fallen on deaf ears, and the West continues to be surprised.

Those in the West who are surprised must be grossly ignorant of history. Soon after reading Kakabadze’s piece, I came across this in Adam Zamoysky’s Moscow 1812: Napoleon’s Fatal March:

Many in Europe [in the early 1800s] were alarmed at this seemingly inexorable onward march of russian power. There was talk of ravening Asiatic hordes and some fear, particularly after the first partition of Poland in 1772, that Russia might engulf the whole of europe as the barbarians had done with ancient Rome. “Poland was but a breakfast. . . where will they dine?” Edmund Burke wondered, echoing the fears of many. Diplomats were struck by the single-mindedness and ruthlessness of Russia’s foreign policy: she did not play by the same rules as others. What few appreciated was the extent to which Russia saw herself as a special case.

The Asiatic hordes are a bogeyman of the past; Russia’s shrinking population, the aging of that which survives, and its economic weakness, mean that its ability to overwhelm any robust resistance is long gone. But the messianic tendencies, the singlemindedness, the ruthlessness, and the belief that Russia is above the rules, are still manifest today. There is a huge mismatch between capabilities and intentions, but western Europe’s pussillanimity and America’s distance and strategic distraction permit Russia to achieve results through aggression and bluster that its military and economic capacities should not be able to support.

For now, anyways. The tragedy is that if and when Russia’s policy of derzhavnost succeeds sufficiently to pose a more serious threat to Western Europe’s immediate interests, its military and economic potential, and that of the United States, will overwhelm Russia’s. And then, it’s 1991 all over again.

So, what we have here is a mutual acting out of Satayana’s injunction about forgetting the past, and repeating it. Or of Talleyrand’s jibe of forgetting nothing and learning nothing. Or of Marx’s aphorism about the past repeating itself as tragedy then farce. Europe and the United States are apparently oblivious to Russia’s historical tendencies, and hence are surprised to see these tendencies re-assert themselves in the aftermath of the supposed end of history. Russia fails to recognize that these historical tendencies have led to shattering defeat on multiple occasions, so plunges ahead on a quixotic quest to reclaim past glories (largely imaginary though they be). This mutual ignorance will lead to a confrontation of some sort sooner or later. But given Russia’s enervated economic, demographic, and military condition, this confrontation will be simultaneously farcical and tragic. And the tragedy will, as it always has, fall most heavily on the Russian people.

[Zamoyski’s book is quite excellent, by the way. It provides a very graphic illustration of the old adage that amateurs talk tactics, professionals talk logistics; he shows that Napoleon’s shambolic logistical preparations doomed his campaign to failure, and his soldiers to misery and death. It also has other interesting tidbits of history that foreshadow current phenomena, such as: “In peacetime [each Russian] platoon functioned as a trading corporation, an artel, leasing their labour to local civilians, with the profits theoretically being shared out between them, though more often going into the pockets of their officers.” A historical continuity that makes me skeptical about the prospects for Medvedev’s military reforms.]

Year 2009 will be the worst for the Russian economy since the World War-II, with the country’s national budget deficit touching the USD
$70 billion mark, says the Finance Minister.

“2009 will be the most difficult for the Russian and world economies. I cannot remember a worse year since the end of the Second World War. This will be the worst year for the economy in modern times,” Russian Finance Minister Alexei Kudrin said last night in a TV interview.

Kudrin, who holds the rank of vice-premier in the cabinet of Prime Minister Vladimir Putin told state-run Vesti TV channel, “In 2009, the budget will have a deficit of 1.5 to two trillion rubles, which we will have to make up from the national Reserve Fund”.

Kudrin’s statement virtually acknowledges the bankruptcy of Putin’s economic model based on high oil prices, with oil windfall fueling the rapid re-emergence of the former Communist country as a global power.

Earlier, the Kremlin aide Arkady Dvorkovich said that the budget deficit could exceed five per cent of GDP in 2009 if the economy does not begin to recover by the middle of the year.

“If the situation follows a negative scenario and the economic recession lasts throughout next year, the deficit could exceed five per cent,” he said.

During eight years of Putin’s rule of consolidation of the state power, the Kremlin had been reluctant to introduce democratic reforms to give economic liberties to the common man, which in the situation of global economic crisis could spark off massive protests and unrest in the country.

Considering that “modern times” “since WWII” includes 1998, that is a pretty sobering prognistication. The reserve fund will be depleted substantially, by about one-third if Kudrin is correct, just to pay pensioners, bureaucrats, the military, and cover other current expenses. (Methinks that paying the military will come close to the top of the priority pile.) For a nation that desperately needs to invest in industry (including in the oil industry that generated the reserve funds in the first place), infrastructure, public health, and human capital, this is bitter medicine indeed. (But the nation plans to plunge ahead in spending on military hardware, budgeting $140 billion over the next three years. Not enough, in other words, to seriously improve its military position vis a vis the US, but more than it can afford to spend with dwindling oil revenues and pressing domestic needs.)

This is a far cry from Medvedev’s or Putin’s standard lines, and is hard to square even with Kudrin’s recent statements that the Russian economy would grow 2.4 percent or so in 2009. One wonders why, so soon after his more optimistic statements, and the government’s fervent denials that a recession was possible in 2009, that Kudrin would say such things on government television.

Kudrin’s pessimism could well reflect last Wednesday’s steep drop in oil prices (a 10 percent decline in Brent, pushing it well below $40/bbl for February delivery. Oil regained about half of that on Friday, and in overnight trading on ICE is up about 4 percent today.) It suggests that the Finance Ministry’s projects that oil prices will remain in the $40-$50 range at best, and perhaps in the $30s, for a good part of 2009.

The ruble fell to a record low against the euro as Russia’s central bank extended six weeks of devaluations to compensate for falling oil prices.

The ruble lost as much as 1.6 percent to 40.8931 per euro before trading at 40.8143 at 12:28 p.m. in New York, the weakest level since the European currency was introduced in 1999. It declined as much as 1.2 percent to 29.0577 against the dollar, a four-year low, capping a 19 percent drop since early August.

Russia’s foreign reserves, the world’s third largest, have fallen by a quarter since August to $451 billion as the central bank sought to prop up the currency and export revenue declined. Standard & Poor’s cut Russia’s credit rating this month for the first time in nine years to BBB on concern Russia is wasting reserves defending the ruble.

And speaking of oil, it takes all my will to fight schadenfreude when reading this:

With Prime Minister Vladimir Putin presiding, energy ministers from 12 gas exporting countries, many of them OPEC members, agreed to transform an existing gas forum that they said could benefit consumers and would not control output or prices.

The event, partly meant to increase Russia’s clout in global energy diplomacy, did not go smoothly for Moscow.

Concern about falling prices and flagging demand quickly surfaced as country representatives said Russia should have sacrificed some of its own output to back up President Dmitry Medvedev’s promise to support OPEC oil production cuts.

The Kremlin’s critics said an important way to help gas prices is to bolster the oil price, which they reflect.

“We needed to redress the situation to the market of oil so as to redress the situation in the gas market,” Libya’s top oil official, Shokri Ghanem, told the ministers.

“We are still waiting for a declaration from the Russian Federation that they are cutting their (oil) production not only to support the (oil) market, but also to support the gas market,” Ghanem said.

Russia, the world’s No.2 oil exporter, has said it is considering all options, including joining the Organization of the Petroleum Exporting Countries, to defend its national interests.

However it did not make any firm pledges when OPEC ministers, meeting at Oran in Algeria last week, agreed their deepest production cuts of 2.2 million barrels per day.

OPEC’s President Chekib Khelil told Reuters on the sidelines of the meeting that Russia had enjoyed the benefit of OPEC’s cuts without sharing the pain.

“If there was no OPEC reductions in September and October, I think we would have seen prices today at maybe $20 (per barrel). So it was because of OPEC that revenues for Russia were at $40 now, not at $20,” Khelil said.

OPEC members were fools to believe that Russia would do anything more than pay lip service to the idea of sharing the pain of output cuts (beyond those dictated by the declining productivity of Russia’s fields). Putin et al were perfectly content to play footsie with OPEC, then let the cartel bear virtually the entire burden of cutting output. (Note that OPEC’s announced cut was larger than originally forecast by almost exactly the amount that Russia had suggested that it would cut–then didn’t.) As I wrote before, there’s no honor among colluders, and Russia’s incentive (given that its exports make up only about 4 percent of non-Russian consumption) is to continue to export as much as possible while others (with a larger collective market share) cut output to prop up prices.

Russia will gain little from this however, because (a) the global demand crunch is likely to be protracted, (b) burgeoning inventories will suppress prices for an extended period, and (c) it is highly doubtful that OPEC discipline will be robust enough to support prices at much above the competitive level.

New Years is the biggest holiday in Russia. It will not be a happy one, and the year that it ushers in is likely to be unhappier still.

Surya submitted a request for a little more on Allen & Gale, and accommodating sort that I am, here it is.

The A&G book presents bare-bones versions of the many models they’ve published over the years. Looking over the book in the context of today’s ongoing financial crisis, it is clear that not all financial crises are alike, and indeed, that the current one does not fit readily into the canonical Allen & Gale model, or the close relatives that other scholars have churned out over the years.

The basic Allen & Gale model focuses on liquidity shocks as the source of crises. In the simple setup, some agents are “early” consumers, some “late.” The early consumers experience a liquidity shock and only get utility by consuming in the first period, none in the second. Late consumers get utility by consuming in the second period. There are two kinds of assets, short term and long term. Long term assets earn higher returns if held to maturity (in the second period), but generate less consumption if liquidated in the first period to meet the needs of early consumers.

The various A&G models study the effect of liquidity shocks (i.e., unpredictable demands for consumption in period 1) in various institutional and contracting environments. They explore how banks can address liquidity risk, and how various sorts of financial frictions (e.g., incomplete contracts, incomplete markets) can result in welfare losses (relative to the first-best, frictionless world) and financial crises. The important point, though, is that the existence of these crises and welfare losses does not justify government intervention unless the government is not subject to the same contracting frictions as private agents–a condition that may well not hold in practice.

The A&G models are elegant, and are sufficiently transparent to permit the reader to understand what drives their results. Exploiting this transparency to examine the fit of the models to the current crisis, I conclude that the canonical models are not that revealing. It doesn’t seem that some sort of liquidity shock–a sudden, unexpectedly large demand for immediate consumption by a large number of agents–initiated the current crisis. Instead, shocks to the balance sheets of large, highly leveraged financial institutions appears to have been the catalyst. These shocks arguably created a liquidity shock, as agents fled to quality (witness zero or negative interest rates on some Treasury securities), but it does not seem that an exogenous liquidity shock is the source of our current difficulties.

The model in A&G that comes closest to capturing an important element of what transpired in the 2000s is their analysis of bubbles. They present a simple model in which an agency problem (the inability of lenders to monitor borrowers’ use of funds) results in the borrowers investing excessively in risky assets in fixed supply (e.g., stock, real estate), thereby triggering a “bubble” (prices in excess of fundamentals.) Borrowers like to invest in really risky assets because of the embedded optionality in debt. If prices continue to rise, the borrowers pocket the gain, but if prices fall, they default, imposing much of the loss on the lenders.

Further, A&G present an analysis in which the central bank, by creating excessive bank liquidity, can initiate and feed a bubble, which eventually pops, leading to collapsing asset prices and widespread financial distress.

This model seems to resonate with what occurred in the early-to-mid-2000s. An overly expansionary monetary policy, in the presence of agency costs in the financial market, leads to an asset bubble that eventually collapses. [It should be noted that the result depends on some segmentation in the financial markets. The depositors that fund the banks that lend to the purchasers of bubbling assets cannot invest in the assets directly. ]

This model is also nice because it puts some formal structure to the intuitively appealing, but largely ad hoc, Austrian theories of credit expansion. In the presence of financial frictions (in A&G, agency problems), expansionary credit policies lead to a distortion in the allocation of capital between high risk and low risk assets. That’s a key element of Austrian theories, and of the somewhat heuristic/descriptive/non-formal models of credit booms and busts (e.g., Minsky). Although not a slave to formalism, I do consider it a plus if one can present a formal model that generates interesting predictions. Formal models permit a more probing evaluation of the causal connections that purely verbal models too often finesse or obscure.

My takeaways from A&G are therefore: (1) financial crises come in many flavors, and the current financial crisis does not comport with the canonical model(s) all that well, (2) agency problems can generate bubbles, especially with a loose monetary policy, and that could represent an important source of our current difficulties, and (3) just because things turn out bad, doesn’t mean that there is some magical government policy that can make them better.

Even though the focus of A&G’s policy analysis is on the canonical model with liquidity-shock driven financial crises, their cautions about policy hold more generally. One must avoid the Nirvana complex–unless government is not subject to the same contracting and informational frictions as private agents, and does not suffer from its own frictions, the government cannot improve on imperfect private outcomes. Moreover, A&G show that the equilibrium effects of various policy tools are frequently quite complex, and often counterintuitive. It is now conventional wisdom that boosting capital requirements is a good thing. Not so fast, say A&G. You need to understand why financial institutions choose the capital levels they do. It may well be the case that private firms choose the capital level that is (information constrained) optimal. Absent better information, or a better contracting technology, a government mandated capital requirement may reduce welfare.

In the end, the Allen and Gale message has a sort of Christian theological tinge. We live in a fallen world, beset by informational inefficiency (the tree of absolute knowledge being denied to us). Due to our lack of information, and our limited contracting tools, laissez faire markets are less than first-best efficient, and subject to periodic crises. But both bankers and governments live in this fallen world. The sins of bankers do not imply that governments are angels who soar above our earthly imperfections. They must cope with the same fundamental informational and contracting disabilities as the rest of us, and as a result, are unlikely to do better–and may do worse–than the fallen bankers. Remember, preachers are sinners too.

A lesson to remember, and ponder, in the months ahead, as Obama takes Roosevelt and the New Deal as his model for the future.

December 23, 2008

The price of oil continues to drop. Earlier today, February Brent fell below $40/bbl. It is now at $40.23. WTI is also down. This follows a rather steep drop yesterday. Inventories continue to build in the US Midcontinent, and reports that oil companies are leasing supertankers to store crude are common. In the Midcontinent, Cushing storage is almost full up. (This is why WTI delivered in Cushing is selling at a discount to Brent, in contrast to the typical relationship where WTI sells at a premium.)

This accumulation of inventory will have a lasting effect on the price of oil. Even when demand turns up (and who knows when when is?), much of that demand increase can be met by drawing stocks down to more normal levels, thereby dampening any price recovery. Inventories may well continue to build, moreover, due to the fact that supply is very inelastic in the short run, and shutting down wells is a costly proposition.

Update: Urals Med (per WSJ) was quoted at $33.87/bbl this PM in Europe. Ouch! Or, should I say –Ð¾Ð¹!

The World Bank called on Russia to abandon the ruble’s managed exchange-rate policy in order to moderate capital outflow, which is set to reach at least $100 billion this year, and safeguard the country’s massive monetary reserves.

A Russian man stands near a currency exchange point in Moscow earlier this month. Shrinking revenue, which has been falling in lockstep with the more than 70% drop in oil prices since summer, has put enormous downward pressure on the ruble.

The recommendation, the World Bank’s firmest on the subject yet, capped a week of economic data making it seem more likely Russia will fall from robust growth to recession.

Zeljko Bogetic, the World Bank’s lead economist for Russia, said that an average price of $30 a barrel of oil over the next two years would be ruinous for an economy that relies hugely on revenue from crude exports. Shrinking revenue, which has been falling in lockstep with the more than 70% drop in oil prices since summer, has put enormous downward pressure on the ruble, which economists consider a commodity currency. This, in turn has led Moscow to try to keep the currency from sliding and avoid widespread fears that another 1998 crash is looming.

. . . .

Meanwhile, monetary authorities have remained determined to defend the ruble and dip frequently into the country’s amassed oil wealth. As a result, Russia’s gold and foreign reserves have shrunk by more than $160 billion since August.

“We’ve seen the monetary reserves dwindle as a result of the central bank’s policy,” Mr. Bogetic said. “We also see now that the policy is increasingly less sustainable.”

I was in Ukraine last week – and a Russian economist mentioned to me that there were demonstrations in Vladivostock against the new tariff on car imports. The FT is now reporting that the trouble is spreading.

More broadly, the Russian government is facing a serious economic crisis on several fronts. Just six months ago, its huge pile of almost $600 billion in foreign reserves seemed a symbol of the country’s new-found strength. But they have got through roughly a quarter of that in just three months – mainly through supporting the rouble. At this rate, it will all be gone well before the end of 2009. That is not an entirely implausible scenario, because the fiscal pressures on the Russian government are only likely to grow over the next year. Official projections are still that the economy will grow by about 3%; but private-sector economists in Moscow are talking about a deep recession. With oil down at just over $40 a barrel, the cash-spigot has been turned off.

There is a danger that, as the government comes under increasing fiscal pressure, it will be tempted to raid the foreign reserves for ordinary budget spending – espescially if the alternative involves cutting social spending and risking further popular unrest. Local governments are also likely to be screaming for financial support from Moscow.

The whole Putin phenomenon has been based on oil wealth and economic growth. So what happens now?

The government’s attempts to play down the seriousness of the crisis are becoming increasingly difficult to pull off. There is simply too much bad economic news hitting Russia from all sides. For example, industrial output fell 11 percent in November. The AvtoVAZ, KamAZ and General Motors auto plants have announced temporary halts to their production lines. There have also been major production cuts in the construction, metallurgical and chemical sectors. The crisis has struck hard in regions that had shown strong export-oriented growth over past years, such as Kuzbass, Chelyabinsk, Lipetsk, Belgorod and Cherepovets. After the long New Year’s holiday, hundreds of thousands of employees will learn that they have just been laid off. An even larger number of workers will face cuts in their salaries even though the average salary before the crisis was only $600 per month.

Exacerbating the problem is the fact that the economies of about 700 Russian cities are dependent on a single major local industry or factory. If those factories shut down, the majority of the people in those cities will have no way to make a living. Kremlin leaders do not have a clear strategy for coping with this looming disaster.

As the crisis is spilling over into the real economy, the people’s tolerance level for government policies is reaching its breaking point. Even before the crisis, the people’s anger over runaway inflation and their eroding purchasing power had been building up over the past few years. In addition, corruption has gotten markedly worse as the level of monopolization in the economy and bureaucratization of government has increased. All of this is pushing people’s discontent to the surface.

Prime Minister Vladimir Putin’s decision to raise import duties on used foreign cars in an attempt to support the country’s struggling automakers unleashed a wave of demonstrations by drivers who will now be forced to pay through the nose for their favorite foreign models. In essence, the government is trying to force new car purchasers to buy far more inferior Russian models — something they would have never done absent the import duties. Drivers protested all across the country — from Kaliningrad to Vladivostok. Riot police brutally dispersed demonstrators at protests in Vladivostok during the past two weekends — a rare example of police using force against ordinary citizens defending their everyday interests. This marks an escalation in the government crackdown on dissent, which up to now was limited largely to breaking up Dissenters’ Marches and roughing up and arresting their members.

The anger over increased import duties is particularly strong among residents of the Far East, the majority of which — perhaps as high as 80 percent — make a living either directly or indirectly connected with the sale or servicing of imported automobiles. The government’s decision only exacerbates the region’s sense of alienation from Moscow. It also strengthens the region’s separatist tendencies and increases the already high rate of emigration from that area.

In Alapayevsk in the Sverdlovsk region, 17 miners are staging a hunger strike to protest unpaid wages. In Magnitogorsk, people have held rallies against layoffs at the city’s iron and steel works and against price hikes for utilities and public transportation. People are also staging rallies in the city of Senezh in the Karelia region where the local pulp and paper mill is on the verge of closing, and the cost of heating and water have shot up by 20 percent and 27 percent respectively.

Moreover, hundreds of banks across the country might go bankrupt in January and February. That could lead to protests by depositors who are unable to retrieve their money, despite the limited government guarantees on bank deposits. In addition, people are upset with the government’s decision to increase utility prices for all homeowners in 2009. This might have been tolerable during a time of steady economic growth and rising standards of living, but it is unacceptable in the midst of a crisis.

For the first time in eight years, demonstrators not affiliated with marginal opposition parties are making harsh political demands. Drivers in Vladivostok demanded that Putin step down, that media censorship cease, that the government reverses its decision to amend the Constitution on increasing presidential and State Duma deputy terms, that the proposed changes to the Criminal Code broadening the definition of treason be annulled and that popular elections for governors be reinstated.

Despite the increasing number of protests against the government, Putin is still maintaining a 83 percent approval rating. But this won’t last for long as the crisis spreads and the protests intensify next year. When Putin gathers with his friends and family on New Year’s Eve, he should forget about raising his glass of champagne and toasting to his eternal popularity. Instead, he should make a wish for a lot of good luck in 2009 — the only thing that can get him out of this terrible mess.

Translated, “Good luck” means “a miraculous recovery in the world (esp. American and European) economy that causes a serious rebound in the price of oil.” So much for that island-of-stability-unconnected-to-the-world’s-economic-trouble thing.

By the way, how could anybody possibly buy the line that an economy largely dependent on energy exports be immune from a world economic slowdown?

Sorry to say, but good luck as defined above seems unlikely any time soon. Given the fundamental dependence of the Russian economy on the price of oil, and the dependence of the price of oil on world economic activity, the drumbeat of bad economic news sounding in the Americas, Europe, and Asia bodes ill indeed for Russia’s economic prospects.

In light of these facts, it is distressing to see Finance Minister Kudrin dating Rosie Scenario: “Russia is not in recession ‘yet’ and the economy will grow by as much as 3 percent next year, Finance Minister Alexei Kudrin said yesterday.” The “yet” reminds me of the joke about the guy who jumped off the roof of a fifty story building. As he passed the 25th floor, he yelled to horrified people watching from the windows: “So far, so good!”

I see 3 percent as a huge stretch. The most recent data show a 1.6 percent year-on-year growth November-to-November. The previous 12 months showed a 6.5 percent year-on-year growth rate. That means that growth in November was roughly -4.5 percent–and that’s NOT an annualized number. Given that (a) the situation appears to be worsening, especially in the manufacturing sector (which is exacerbated by the ruble policy), and (b) the oil price continues to decline, worse is likely to come.

Kudrin is evidently in a very weak position, beset by myriad enemies earned over the years. (And, since you can often judge a man by his enemies, the number and identity of his speaks highly of him.) Thus, he may be echoing the party line out of self-preservation. I am therefore willing to cut him some slack. But I cannot credit his optimism as a realistic forecast.

The excessive reliance on nuclear forces is not a comforting thought, especially in unsettled times with a revanchist, aggressive, and arguably paranoid leadership with its finger on the button. It should be noted, moreover, that the paranoia may stem in part from an acute sense of weakness arising from the decrepit state of virtually all of the nation’s armed forces. Grandiose imperial ambitions and a deep sense of weakness and insecurity are a volatile combination indeed, especially when economic troubles may make foreign adventures a welcome distraction for a nervous, unsettled population.

In yet another indication that Moscow fears protests in the regions could get support from local governments and thus represent a threat to itself, Prime Minister Vladimir Putin send OMON units from Moscow, Daghestan and two Siberian cities to ruthlessly suppress a second weekend of demonstrations in the Far Eastern city of Vladivostok.

But his transparent effort to send a message to more than just the residents of the Russian Far East appears to have backfired. Not only have people elsewhere organized similar protests, but some Russians are asking why Moscow television has not reported on the Vladivostok events and even whether the Duma should reverse Putin’s order imposing tariffs on foreign cars.

The use of troops from one region to enforce order in another is a well-established imperial policing technique, historically employed not just in Russia but in other empires as well. Moreover, it is tantamount to an admission of distrust in the reliability of one’s troops.

Per earlier posts–and debates with Timothy & DR–this is yet another indication of the authorities’ jumpiness about their control over the population. Whether this reflects a sober appraisal of the situation, or paranoia, or both, is impossible to tell. But does it really matter? Indeed, paranoia-induced heavy handedness could spark the very unrest that Putin evidently fears so much.

December 21, 2008

Many modern historians of Russia, Stephen Blank comes immediately to mind, draw strong parallels between the current trajectory of the Russian state (and sometimes society) and its tsarist and Muscovite predecessors. I came across this article (based on a chapter in a book) by Thoedore Dalrymple that certainly evokes such comparisons. It is an essay on the Russian travelogue of the French nobleman, the Marquis de Custine. Dalrymple focuses on Custine’s discussion of the underlying dishonesty of tsarist society. In light of recent events, Dalrymple’s (and Custine’s) descriptions of early-19th century Russia resonate today:

Custine grasped that the propensity to deceive and to be (or to pretend to be) deceived lay at the heart of Russia’s evident malaise. The maintenance of despotism depended upon this universal vocation for untruth, because without the fiction that the despotism was necessary, that it conduced to the happiness and well-being of all, and that any alternative would be disastrous, the subject population would cease to be controllable. The inability to speak even the most evident truth perverted all human relationships and institutions. And of course the lie came to be the foundation of all twentieth-century totalitarian regimes, without which they could not survive. “The political system of Russia,” wrote Custine, “could not withstand twenty years of free communication with Western Europe.”

Unlike so many gullible intellectuals of the twentieth century who visited communist countries in the spirit of religious pilgrims, Custine understood only too well both the techniques and the meaning of the attempts to deceive him. “Russian hospitality, bristling with formalities . . . is a polite pretext for hampering the movements of the traveller and limiting his license to observe,” he concluded. “Thanks to this fastidious politeness, the observer cannot visit a place or look at anything without a guide; never being alone he has trouble judging for himself, which is what they want. To enter Russia, you must deposit your free will as well as your passport at the frontier. . . . Would you like to see . . . a hospital? The doctor in charge will escort you. A fortress? The governor will show it to you, or rather, politely conceal it from you. A school, any kind of public establishment? The director, the inspector, will be forewarned of your visit. . . . A building? The architect will take you over all its parts and will, himself, explain everything you have not asked in order to avoid instructing you on the things you are interested in learning.” No wonder, he added, that “the most highly esteemed travellers are those who, the most meekly and for the longest time, allow themselves to be taken in.” No visitor to a communist country could fail to recognize the description.

For the whole elaborate charade of despotism to work, for the pretense that the despotism is both indispensable and conducive to the welfare of all, everyone must appear to believe in itâ€”including the despot himself. The czar, as a consequence, remains trapped in a permanent state of fear and irritation, because he knows that he is not in fact omnipotent, but he cannot acknowledge openly this obvious fact and he cannot permit anyone or anything else to question the pretense on which his authority depends. “Subjecting the world to his supreme commands,” Custine says of him, “he sees in the most insignificant events a shadow of revolt. . . . A fly that buzzes unseasonably . . . humiliates the Czar. The independence of Nature seems to him a bad example.” Any rebellious behavior on the part of the meanest of his subjects assumes a disproportionate importance and must be ferreted out and put down. So the czar, through an army of spies, must keep an eye on everyone. He is “both eagle and insect, soaring above the rest of humanity and at the same time insinuating himself into the fabric of their lives like a termite into wood.” His position compels him to be paranoid: “an Emperor of Russia,” wrote Custine, “would have to be a genius . . . to keep his sanity after twenty years of ruling.” Such, of course, was precisely the problem all communist dictators faced.

“His position compels him to be paranoid.” “[A]n Emperor or Russia . . . would have to be a genius to keep his sanity after twenty years of ruling.” Putin’s latest diatribe, and other actions, suggest that the compulsion to paranoia has had its inevitable effect.

If the czar is all-powerful, he is of course responsible for everything: therefore nothing untoward can happen in the country without the imputation of the czar’s ill will. But in that case, how is the imputation of omnipotence to be reconciled with that of perfect benevolence? If something terrible happens to innocent people, either the czar must not be omnipotent or must not be benevolent. The only way to square the circle is to lie oneself and be deceived when others lie in similar fashion: to see no evil, hear no evil, and speak no evil, even when evil abounds.

For example, shortly after his arrival in Russia, Custine went to the annual festival at the palace of Peterhof, a festival of such magnificence that it took 1,800 servants to light 250,000 lamps for it. Visitors reached the palace by boat from Saint Petersburg, and one boat had sunk in a storm on the way to the festival with the loss of all its passengers and crew. But because “any mishap [in Russia] is treated as an affair of State” in Russia, and because “to lie is to protect the social order, to speak the truth is to destroy the State,” there followed “a silence more terrifying than the disaster itself.” In Russia, people of the highest social classâ€”as were the boat’s passengersâ€”could disappear not only without a trace but without comment. Who in such a country could ever feel safe?

The silence encompassed not only current events, but extended back into history. A Russian nobleman, Prince Peter Koslovsky, had warned Custine before his arrival in Russia that in his country “despotism not only counts ideas and sentiments for nothing, but remakes facts. It wages war on evidence and triumphs in the battle. . . . [The Emperor’s] power is more far-reaching than God’s, for God makes only the future, while the Czar remakes the past.”

[The last remark is particularly apposite, given the government’s attempts to re-write the history books, and rehabilitate Stalin, among other things.]

Custine also noted the profligate expenditure of humanity by the Russian state:

Custine could wring meaning even from stones: a great interpreter of the meaning of architecture, he caught from the buildings and streets of Saint Petersburg another deep glimpse into the Russian soul. The city, to which he did not deny a certain beauty, was to him the physical embodiment of despotism. It was founded as the imperial capital not for the benefit of the Russians, as the natural expression of their economic or social activity, but as a permanent bulwark of the czarist regime in the Baltic against the Swedes. The very selection of the terrainâ€”a freezing swampâ€”for the construction of a city by the fiat of the czar was an expression of contempt for humanity, for in such a place construction necessarily entailed the deaths of hundreds of thousands of men. Custine noted that the stucco that veneered Saint Petersburg’s grandiose government office buildingsâ€””temples erected to clerks,” he called themâ€”was a material peculiarly unsuited to the Russian climate, such that it took thousands of workmen to restore the crumbling stucco in the three-month plastering season every year, large numbers of them meeting death in the process because of the flimsy scaffolding on which they worked. Only where human laborâ€”and life itselfâ€”ostentatiously counted for nothing could such a system of building maintenance have been envisaged, let alone tolerated.

This point was brought home to me by something I watched on History International last week–“Building Empires: Russia.” It presented the histories of myriad gargantuan projects in Russia, and their vast toll in human life. The irony is that although at one time western Europeans viewed Russia as a land of numberless human hordes, today the country is dying. In the past–as recently as Soviet times–Russian leaders expended millions of lives with little thought to achieve their vision of derzhavnost. Today the vision lives on but the human means to achieve it are rapidly ebbing away.

Dalrymple’s and Custine’s critical view of the inherent dishonest of despotic/autocratic systems is shared by Richard Pipes. Pipes’s autobiography, Vixi, emphasizes that the thing that repelled him most when visiting the USSR was the pervasive dishonesty, and its corrosive effect on human relations.

With Putin’s quasi-ideology, which tries to make the contradictory elements of his ideology plausible, he was forced to hide facts and distort reality. His last presidential address (May 26) was typical in this respect. Putin eliminated the division of power in the country, and took control of the media (according to Freedom House, among 29 countries of the former Soviet block, Russia is in 29th place with respect to its level of democracy). However, in spite of the evident facts, the president has taken the posture of a great champion of democracy, freedom and civil society, while sending a clear signal to the state bureaucracy and media that they should, as in Soviet times, always sort the Kremlin’s statements into real commands and pure propaganda, as well as the declarations related to the public ideology, and those reflecting the Kremlin’s real views. The seasoned Russian bureaucrats, who have not forgotten how to decode Pravda’s editorials, will pay much more attention to the statement that “freedom should be responsible,” or that some nongovernmental organizations are too interested in acquiring money from abroad, which is indeed a sinister signal for the already weak liberal structures in the country. When Putin’s apparatchiks learned in June 2004 that the most liberal program on Russian TV, Leonid Parfenov’s “The other day,” was shutdown under some ridiculous pretext, they saw this as a real message to continue suppressing democracy in the country. Other similar signs included the case of Putin’s youth organization “Moving together,” which declared war on all four of the remaining liberal newspapers. Senator Liudmila Narusova, Putin’s puppet and the wife of the late Anatolii Sobchak, suggested the necessity of censoring the Internet.

The list of blatant falsehoods uttered by Putin probably started in 2001 during his trip to Spain. Responding to a reporter’s question, he said that he was unable to contact the general prosecutor in order to inquire about why the famous oligarch Vladimir Gusinsky had just been arrested. The list of such behaviors had already grown quite long by June 2004. It included statements about the Kremlin’s “neutrality” in the Khodorkovsky affair, about the handling of the terrorist attacks against the Moscow theater in October 2003, the case of Levada’s All Russian Public Opinion Center, and about the “honest” character of the election of the Chechen president Akhmet Kadyrov in 2003.

As the prominent Russian journalist Evgenii Kisilev courageously noted in regard to Putin’s position on the Yukos affair, “there are many cases when the real facts are very different from the president’s words.” Andrei Piantkovsky, another prominent journalist, went even further in describing Putin’s loss of reality. He compared Putin with the ailing Lenin who in 1922 read an issue of Pravda that had been prepared only for him by the members of the Politburo in order to provide the leader with some pleasant news about the country. The diagnosis of Putin as a leader who lost contact with his country has become a popular theme among all Russian journalists who can afford to take a critical stance toward the Kremlin.

His personal initiative to double the GDP by 2010 aroused skeptical comments not only among the Russians (only 10 percent of them believed in the feasibility of this goal), but also among people close to him, including his Minister of Economy German Gref who at the meeting of the government in June refused, as noted in Izvestia, “even to hint at the theoretical possibility of the implementation the president’s wish.” Foreign experts point to many conditions that must be met in order to attain this goal, as suggested by the mission of the IMF, which visited Moscow in June. A Russian newspaper published the conclusion of the mission with the title “The IMF mission hits Putin where it hurts.”

Some of Putin’s subordinates were even more eager to distort reality along the “party line.” Prime Minister Mikhail Fradkov declared a plan to replace the contribution of oil production to the GDP growth by three times “in the next few years” by “uncovering sources of economic growth that are based on diversification, strengthening the competitive position of Russian enterprises in domestic and foreign markets, and improving the entrepreneurial climate by stimulating investment, introducing new technology, and organizing ways of doing business.” Even in the giddy days of the first five-year plans, Stalin did not promise to radically change the technological and organizational structure of the economy in “a few years” as Putin’s prime minister did. His promises look like something out of one of Baron Munchausen’s fairytales. In light of Fradkov’s fantasies, it is not amazing that the president, during his meeting with the president of Dagestan in June 2004 on Russian TV, did not utter a single word of skepticism when the president of Dagestan, one of the most impoverished republics in the country, promised to “triple the GDP.” Moreover, Putin remained silent when his agriculture minister declared, also in June, that Chechnya, which has been ravaged by war, “would soon flood the country with grain.” Putin also shows his denial of reality when he avoids in his public speeches the most acute issues that are vehemently discussed in society. In July 2004, for instance, Putin did not say a word about his attitudes toward the government’s decision to monetize the benefits of retired and handicapped people – a move that aroused uproar in the country. Putin also avoided discussion on the topics of the threat of a banking crisis and the conflict with Georgia over Southern Osetia (a Georgian region that proclaimed itself independent).

Putin’s grip on reality fell into question when he exclaimed in May, after viewing the Chechen capital Groznyi from the air, that he had never imagined such destruction left by the war. He also showed some amazement when he visited the sailors’ hostels in the Far East, declaring that he had never guessed that the conditions could be so terrible.

Putin’s own plans as well as the competition among his subordinates to draw his attention with “bold initiatives” and “projects” are reminiscent of the last years of Nikita Khrushchev’s regime when the general secretary suggested the utopian idea of catching up the United States in two or three years in the production of milk and meat. Both then and now, bureaucrats competed with each other to win the favor of the leader by making spectacular promises. As I was told in the mid 1960s by Khrushchev’s son-in-law Alexei Adjubei, the general secretary was once confused when he saw a ridiculous poster, the brainchild of an overzealous party bureaucrat, that read “Let us double the production of milk by four times.”

The historical continuity between Custine’s Russia and today’s is dispiriting. Dalrymple writes:

Custine could prophesy that within two or three generations a violent taclysm would occur that would spell not liberation but a renewed and more terrible form of despotism, for men with souls molded by czarism would have no vocation for freedom. The trmoil that Russia has experienced in escaping the legacy of communism [Dalrymple was writing in 2000] would not have surprised Custine in the least, nor would he have expected a happy outcome at any time in the future.

December 19, 2008

There is an increasing flow of articles that openly discuss the potential for unrest in Russia, and the government’s likely response to it. From Eurasia Daily Monitor:

Vladimir Putin’s government will, understandably, behave very cautiously when it comes to raising gas and electric bills so as not to provoke mass discontent which might threaten the government’s hold on power. It is entirely possible that the 2009 budget might not be able to cover projected social payments as a result of Gazprom’s projected shortfall. The choice between saving Gazprom, meeting the state’s social obligations, and clinging to power will be the bottom line.

Nonetheless, it is apparent that Putin’s ruling “United Russia” party and Putin himself are terrified of popular unrest. One proof of this is a recent change to the Russian criminal code, voted into law by the United Russia party and the Liberal Democratic Party on December 12. The change forbids a trial by jury not only in terrorist cases, hostage taking and the attempts to overthrow the government, but also for “mass disturbances,” “diversions,” “treason,” and “espionage” (Kommersant, December 15).

According to Kommersant Daily (December 15), Russian human rights activists and lawyers fear that these changes in the Criminal Code will make any critic of the regime potentially guilty of “espionage” or “treason” and therefore liable to a trial without jury, as was the practice during the Stalinist era when so-called “troika” tribunals passed sentence on defendants who were guilty until proven innocent.

It appears that the Putin/Medvedev duumvirate is facing the most severe challenge to its oligarchic rule. Will it manage to contain mass discontent in the countryside or will it resort to mass repression in order maintain its hold on power?

In November President Medvedev ordered senior police officials in St. Petersburg to stamp out any social unrest linked to the financial crisis. “If someone tries to exploit the consequences of the financial crisis â€¦ they [the police] should intervene [and] bring criminal charges, otherwise there won’t be order” (Moscow Times, December 12).

The collapse of oil prices and the Russian ruble have ignited relatively small protests against the government here. But reaction from the Kremlin has been fast and furious.

Nationwide rallies planned for Sunday are expected to draw even larger crowds and will be the next major test of a Russian leadership increasingly anxious over dissent.

Leaders of the still-influential Communist Party, which is staging the upcoming rallies, say the Kremlin’s fears were on display during protests last weekend in Moscow and St. Petersburg, when thousands of riot troopers confronted a few hundred demonstrators from the Other Russia, a broad anti-Kremlin coalition, and arrested 150 of them.

“On its face it seems ridiculous to see thousands of cops beating up a handful of peaceful demonstrators; logic dictates that they ought to ignore us,” says Eduard Limonov, leader of the banned leftist National Bolshevik Party. “But the authorities fear opposition and … [as the economic crisis grows] they have good reason for that. They read the FSB [security police] reports and they know that we are very well organized and ready to lead in the case of mass social unrest.”

. . . .

In the 1990s, opposition parties dominated the Duma, and a more open, robust media existed. Experts warn that the concentration of power in the Kremlin under Vladimir Putin, and the near monopoly held by the United Russia Party, which Mr. Putin leads, leaves few outlets for dissent and no alternative avenues for spreading responsibility in the event of economic failure.

“The authorities argue that social stability has been the great achievement of the Putin era, and they are very much afraid of losing this image,” says Vladimir Gimpelson, a professor at Moscow’s Higher School of Economics. “The political system has become too rigid, and if unrest begins, there is a danger it can be completely broken.”

Prof. Gimpelson’s point about the rigidity of the Russian system echoes my arguments about the brittleness of the “power vertical.”

Putin did not specify who might pose a threat to Russia’s stability. But in the past, he has often blamed Western security services of trying to destabilize the country using opposition groups and non-governmental organizations as their instruments.

“Any attempts to weaken or destabilize Russia, harm the interests of the country will be toughly suppressed,” they quoted ex-KGB spy Putin as telling an annual meeting of top spies and security officers ahead of their professional holiday.

Putin was speaking ahead of “The Day of Security Officers” which “is marked annually on December 20, a day when in 1917 Bolshevik rulers created the CheKa secret police to suppress their foes.” Tell me again what countries have holidays commemorating secret policemen to be held on the anniversary of the formation of an organization that committed mass murder and terror for seven decades.

The Kremlin has tried in state media to downplay the impact of the global financial crisis. Yet popular discontent is growing.

Last weekend, thousands of angry residents in the far eastern city of Vladivostok took to the streets and blocked traffic to protest government plans to raise tariffs on secondhand foreign cars, which are one of the impoverished region’s biggest moneymakers. Similar protests have been attempted in Moscow, St. Petersburg and Kaliningrad, and further demonstrations are planned for Sunday in Vladivostok.

Public anger also spilled onto the streets this fall in the Siberian town of Barnaul, as thousands of pensioners who had lost their right to discounted public-transport tickets staged noisy protests.

The government’s response says a lot about the Kremlin’s growing angst over the financial crisis. After several tense days, the pensioners got their discount tickets back, police detained younger protesters who had joined the demonstrations, and state media made little mention of the events.

The prospect of further unrest poses what could be the biggest challenge yet to the authoritarian system built by Mr. Putin. It also foists a stark choice on the Kremlin: to stifle dissent, or to placate protesters to provide some kind of pressure outlet. For now, the Kremlin has decided on a mixture of both. But the government’s options may narrow as its financial reserves shrink.

“They’re incredibly scared of this,” says Yevgeny Gontmakher, an economic adviser to the Kremlin. “They don’t know how to operate in this environment.”

. . . .

This fall, Barnaul, an ailing Siberian industrial hub some 2,000 miles south of Moscow and one of the last regions to benefit from the oil boom, became one of the first to feel the crisis.

As the credit crunch poisoned Russia’s economy, supply chains broke down on a lack of cash and trust, and orders dried up at the town’s factories, which churn out diesel engines, heavy machinery and tires.

Three months ago, workers say, several factories sent workers home on reduced salaries until better times. Government data show over 1,000 workers in the region are in the process of being laid off; opposition lawmakers say hundreds more layoffs are likely.

In late October, when authorities revoked subsidized transport tickets for more than 200,000 pensioners in Barnaul, they gave no warning or explanation. When the pensioners — among the poorest groups in Russian society — learned the tickets were being axed, they panicked.

On Oct. 26, about 1,500 gathered in front of the regional government building to protest, according to people who attended. The pensioners blocked the town’s main thoroughfare, Lenin Avenue, for three hours, and only dispersed after a local government official invited a few of the leaders inside for a chat, promising the tickets would be reinstated.

Still, protesters came back the next day. This time, they numbered only a few hundred but demanded the resignation of the local Kremlin-appointed governor, Alexander Karlin.

In a third protest, a crowd of 2,000 again blocked Lenin Avenue as regional lawmakers debated the decision to do away with the discount. Some demonstrators tried to storm the government building, but police lines held. The governor tried to calm the crowd, but was forced to retreat.

Eventually, the government decided pensioners could keep their discounted transport tickets, while a new system allowing them to choose between cash payments and free transport passes is introduced.

. . . .

But political opponents believe remote regions and towns like Barnaul are the Kremlin’s Achilles’ heel. “They can only control what’s within the Moscow ring road,” says Vitaly Boldakov, a left-wing activist in Barnaul. “But beyond that road, their control collapses.”

Boldakov’s point about the center’s tenuous control over the regions is well taken. Several governors are already asserting their independence in small ways. Others are voicing their fears to the central government.

With domestic and foreign companies curtailing car production in Russia and warning of potential layoffs, the Kremlin is increasingly worried about the fate of car manufacturing and its related industries, which altogether employ more than 1.5 million workers.

Putin called for setting up a national leasing company to buy locally made cars and for compensating the state rail monopoly for transporting Russian cars thousands of miles to distant regions in the far East.

He made a show of moral support for truck giant Kamaz Friday, visiting its plant in the central Tatarstan region Friday.

“Now that our producers are forced to slash production, I think it is absolutely unacceptable to spend money on acquiring foreign cars,” he said, according to a transcript posted on the government’s Web site, referring only to foreign imported cars, not foreign cars manufactured in Russia.

Putin said foreign manufacturers operating in Russia might also be eligible for state support if they meet “production localization requirements.”

While few government bureaucrats drive Russian-built Volga sedans, Putin himself is chauffeured around in a black Mercedes limousine.

The government had earlier announced it would raise tariffs on imported cars, including used cars.

That issue has sparked a grass-roots uproar in many regions, where importing and using used cars is big business, such as the far Eastern regions of Primorye and Khabarovsk, where the cars are almost entirely imported from Japan.

Last weekend disgruntled motorists in Primorye’s capital city, Vladivostok, staged a large protest against the higher tariffs, which come into effect in January.

That demonstration â€” and others planned for this weekend in more than 40 cities â€” are the largest show of public dissent in some time in Russia, where vocal opposition to the Kremlin has been all but silenced.

Putin tried to address some of those concerns during his visit to the Kamaz factory.

“I regularly visit the Far East, meet with people there, and I think they have reasons for their concern. Many people asked me: ‘Why should we buy Russian cars at prices that are two or three times higher than in European Russia?'” Putin said.

As the economy sputters, Russia’s car industry has floundered as people hoard their cash, banks stop offering credit and demand for big-ticket items plummets.

Major Russian car and truck makers have announced production shutdowns and have appealed for a government bailout. Foreign carmakers Renault and Ford have announced a temporary suspension of production at their Russian plants.

Russia was expected to emerge as Europe’s largest car market next year, but sales of foreign brands fell 15 percent in November year-on-year, the first decline in at least four years, according to figures produced by the Association of European Businesses. These included cars not made in Russia.

Russia is heading into its toughest economic period in a decade as oil prices tumble and falling demand for metals, cars and other goods has resulted in thousands of job losses and production cuts.

The uproar over import tariffs could be the tip of the iceberg, as civil unrest pops up in other regions. Migrant workers recently protested wage arrears in the Urals city of Yekaterinburg. In the Siberian town of Barnaul, pensioners took to the streets to protest the withdrawal of discounted fares on public transport.

There appears little the government can do now to fight the recession other than to devalue the ruble sharply, perhaps, by as much as 30 percent, in one drastic move to promote import substitution and prevent the depletion of currency reserves. This move, however, poses serious risks of social and political instability, and will obviously undercut Vladimir Putin and Dmitry Medvedev’s popularity. The Kremlin, aware of brewing unrest, has instituted a sweeping system of social monitoring and rapid reaction that involves all levels of political power and even the United Russia party.

Ethan Burger adds:

Attempts to control the flow of information to the citizenry only make it more anxious. At some point, a government’s lack of credibility will come back to haunt it. There is more to fear than fear itself. In the absence of information, people are clueless as to what they should do as workers, savers, investors and consumers

Indeed.

I could go on, but I think the point is pretty clear. Discontent is rising, albeit slowly, and the authorities are very, very nervous. What is remarkable is that the full economic impact of the crisis has not been felt. The layoffs are just beginning. The prices of real estate are just beginning to fall:

lMoscow residential property prices fell 2.3 percent to $5,972 a square meter in November. By December 15, prices had dropped another 6.9 percent to $5,558 a square meter, according to data compiled by Bloomberg.

Analysts from UniCredit suggests that prices will fall 25 to 50 percent, and Goldman Sachs is predicting a 32 percent fall in dollar terms.

Absent a rapid rebound in the price of oil–not something that appears to be likely in the near term–the situation will only worsen. The price of oil depends on what happens in the US and Europe, and the picture here/there is still grim, with no immediate prospect for a turnaround. That means no immediate prospect for a turnaround in Russia. I remain very pessimistic as to how a brittle political system that has not dealt honestly with the citizenry will withstand a prolonged economic trial.

Today’s title selection was inspired by Led Zeppelin, and Russia’s zig-zag policy on electricity price reform. First it was reported that Russia would slow the reform. Then Putin said it wouldn’t be slowed. Then Kudrin said it would be. Now? Well, for what it’s worth:

Russia’s economy minister said on Wednesday the government is sticking to its 2009 plans for the power sector and will not be moved to amend them by the global financial crisis, Russia news agencies reported.

Her statements seemed to conflict with previous comments from top officials, who have said plans to raise electricity prices will have to be corrected.

But the growth in gas prices will be made more gradual, Minister Elvira Nabiullina was quoted as saying. The move would ease the cost for consumers already suffering from desiccated credit markets and falling stocks.

The price of gas will grow 5 percent in the first quarter, 7 percent in both the second and third quarters and 6.2 in the fourth quarter, the agencies reported her as saying.

This compares to earlier plans to raise the prices by around 25 percent as of Jan. 1, part of a plan to gradually bring domestic gas prices to parity with with Europe by 2011.

Nabiullina made the statements while presenting the government’s revised macro-economic forecasts [ID:nLH161149].

“We have factored decisions (into the forecasts) on revising the rate of price growth for natural monopolies,” she said, Interfax reported.

Officials generally use the phrase natural monopolies to refer to electricity, gas and railway service.

“For gas it has been decided that prices will rise at a smoother quarterly rate for all consumers, including households,” she said, the news agency reported.

But her comments on electricity contradicted other top officials, including Finance Minister Alexei Kudrin, who said on Monday that price growth for power, rail and gas services List of stories in basket would be significantly cut due to the crisis [ID:NLF154185].

As Casey Stengel once said: “Does anybody know how to play this game?” This erratic, contradictory policymaking is hardly conducive to restoring confidence in the Russian economy, the Russian government’s management acumen, or the reliability of its promises and the credibility of its policies. In a country where the government plays such a dominant economic role, lack of policy credibility is a major impediment to attracting investment, especially in sectors like power.

So what’s the real policy? Who knows? I mean literally–who knows? Putin? Medvedev? Kudrin? This ongoing to-ing and fro-ing seems to suggest that there is a major fight going on behind the scenes. The only conclusion that investors can draw is that one can draw no conclusions. So it is best to stay away. Very far away.

Given Russia’s pressing needs for infrastructure investment, not just in power but in other sectors, the combination of the bleeding of reserves and the policy chaos mean that these needs will not be met for years to come. Yet another tragedy.

But look on the bright side. The glorious Russian Navy is visiting Nicaragua and Cuba! One needs to keep one’s priorities in order!

December 18, 2008

The ruble fell to a record against the euro as Russia devalued the currency for a second time this week amid tumbling oil prices and shrinking reserves.

The ruble weakened to an all-time low of 40.1096 per euro, and was 0.8 percent lower as of 2:39 p.m. in Moscow. Bank Rossii allowed the ruble to decline as much as 1.4 percent against its target basket of dollars and euros, the eighth depreciation since Nov. 11, according to a bank official who declined to be identified. The currency fell 15 percent versus the dollar since August.

This slow motion devaluation is widely recognized to be a major policy error:

“It’s better that they do this quicker rather than slower because everything is looking particularly weak in Russia with the oil price where it is,” said Eugene Belin, head of fixed income, currencies and commodities in Moscow at Citigroup Inc. “The sooner they’re finished with this devaluation process the better for the economy.”

Maintaining the ruble at a level higher than justified by fundamentals bleeds reserves, and weakens the country’s ability to deal with macroeconomic and terms of trade shocks in the future. Moreover, it damages Russian domestic manufacturing. Russian industry faces competitiveness problems even absent an inflated currency–propping up the currency only exacerbates that problem. Note that Russia’s recovery from the 1998 disaster was greatly helped by the adjustment of the currency to reflect fundamentals.

So why is Russia boiling the frog by slowly turning up the temperature gradually, rather than allowing the currency float to a level that reflects the dismal fundamentals now facing the country? The answer is almost certainly domestic politics. Although several commentors have pooh-poohed my arguments that pronounced and protracted economic difficulties could spark domestic unrest, especially given the fundamentally dishonest way Putin and Medvedev are dealing with the situation, it seems that some people in Russia agree with me about the potential for civil disorder. People like Putin, Medvedev, and the security forces:

In expectation of uprisingsThe powers have rethought reducing interior troops

Yesterday, the MVD [Ministry of Internal Affairs] decided not to reduce the interior troops (VV), called upon, in part, to disperse demonstrators. The command of the troops justifies this by «tasks that have been set », without specifying them. In the opinion of experts, the siloviki seriously fear unrest among the unemployed, automobilists, discharged military, those dissatisfied with the growth of housing-and-public-utilities tariffs and other victims of the crisis and of the decisions of government officials.

«Reduction of the internal troops of the MVD of Russia will be suspended », — reported, citing a decision of the leadership of the country, commander in chief of the VV general of the army Nikolai Rogozhkin. He in no way connects the decision to maintain the numbers of the VV with the financial crisis, citing the «necessity of fulfilling all tasks that have been set », but which ones specifically, Mr. Rogozhkin does not specify.

«Our troops are designated for the protection of state and industrial facilities, convoying of special cargoes, defense of service lines, suppressing internal unrests and resolving inter-nationality conflicts on the territory of the country, — clarified an RBK daily source in the VV. — Probably, the leadership of the country is assessing the domestic political situation as not very stable, which is why it rethought reducing us ».

The consequences of the crisis and unpopular decisions of the powers have already brought people out on the streets. In Vladivostok a march of protest of several thousand automobilists against the increase in customs duties for used foreign makes went outside the thematic bounds: people started talking about the costliness of fuel, food products and housing-and-public-utilities services, about unemployment, the crisis and property stratification. A protest rally against the growth of housing-and-public-utilities tariffs on 15 December took place in Izhevsk, while on 21 December in the Far east and in Khabarovsk Kray are expected new protests of automobilists. The slogans of the protestors have remained unnoticed by the central telechannels, but have attracted the attention of the siloviki: in the regions are being created anticrisis special groups of the MVD, the heads of the territorial administrations of the FSB are likewise expecting protest actions. MVD analysts are attributing to the risk group reduced military and rotation workers come back from Moscow. Also pouring oil on the fire are growing wage arrears. Thus, according to the data of Rosstat, overdue indebtedness on wages in November increased in Russia by 93% and comprised 7.765 bln rub.

«As much as I know, the power elites are seriously concerned by people’s unrest associated with the financial crisis, — clarified to RBK daily the political scientist Stanislav Belkovsky. — In the situation that has evolved the Kremlin has two ways out: pinpoint financial injections and cracking down on demonstrators with the help of internal troops ». In the opinion of Mr. Belkovsky, the peak of people’s dissatisfaction is going to come in the first quarter of the year 2009: «The ranks of the demonstrators will be augmented as well by people deprived of mortgaged apartments, because for this period is planned their mass repossession ».

As Russia has experienced numerous times in its history–think 1905, 1917, 1991–protests of this sort can snowball. Protesters must overcome collective action problems, and isolated protests can be crushed. When the level of discontent becomes sufficiently great, and a critical mass of protests occurs, it is easier for protestors to coalesce as the security forces become spread more thinly.

The car tariff decision reeks of desperation in the Kremlin–and the White House (on the Moskva). An ad hoc response taken in haste to defuse one problem creates another. Putin has few good options. With the entire economy imploding, everybody is hurting, and moves to help one sector will only aggravate the suffering in others. Such clumsy moves will quickly undermine the aura of competence surrounding Putin–an aura created by luck (skyrocketing prices for raw materials and a predictable recovery from an inherited economic disaster) rather than by any real economic policy acumen. Once this aura disappears, the potential for protests and disenchantment grows. He has only made the ultimate reckoning worse by his failure to level with the Russian people about the seriousness of the situation. How will Putin likely respond? I think we all know (and dread) the answer–the answer implicit in the strengthening of the MVD.

Russia’s ruble problem has been eased somewhat by the precipitous drop of the dollar against the Euro and the Yen. The Fed’s dramatic easing is, in my view, highly unwise. It appears to be doing little to spark the economy (high powered money is increasing, but velocity is decreasing, meaning that the injection of cash is largely being hoarded.) Moreover, the huge dollar overhang that is building up will threaten a sharp increase in the price level when the banking crisis eases and financial institutions start lending, rather than holding, this cash hoard. This will likely lead the Fed to dramatically reverse direction, raise interest rates sharply, and throttle any recovery in the crib.

The continuing fall in the price of oil–January NYMEX WTI closing at $36.25–is particularly remarkable in light of the substantial drop in the dollar in recent days. Ordinarily, the sharp drop in the dollar would cause an increase in the price of oil. Not this time.

Doubly remarkable, in fact, in light of OPEC’s record cut. Or should I say, intended cut. As I’ve said ad nauseum, these are pie crust promises (to quote Mary Poppins), easily made, easily broken. The market’s sell-off in the aftermath of the OPEC meeting reflects (a) widespread skepticism about the willingness of OPEC members to adhere to the cuts, especially in the face of pressing budgetary needs and excess capacity, (b) continuing economic weakness and plummeting demand, as indicated by ballooning inventories, and (c) (drum roll please) Russia’s Lucy-and-the-football move of promising cooperation with OPEC, and even intimating joining the organization, and then refusing to cut output:

Russia is not in talks over joining OPEC and has not pledged any oil output cuts in its memo to the oil producers’ group this week, deputy energy minister Anatoliy Yanovsky said on Wednesday.

“There is no talk of Russia joining OPEC,” Yanovsky told reporters, adding that Russia has given a memorandum of cooperation to the Organization of the Petroleum Exporting Countries.

President Dmitry Medvedev said Russia may join the Organization of Petroleum Exporting Countries and reduce production to support the oil price.

“We have to defend ourselves,” Medvedev said in the Ural Mountains city of Kurgan today. “This is our revenue base, both from oil and from gas,” he said. “I believe that we mustn’t rule out any options.”

Defensive measures may include “cutting the volume of oil production and participating in existing organizations of suppliers, and in new organizations, if we can reach such an agreement,” Medvedev said in comments broadcast on state television.

So, the options are: (a) Medvedev was lying, and Russia had no intention of cooperating with OPEC let alone joining it, or (b) Medvedev gave his honest opinion, and was sandbagged by the real powers in Russia. Regardless of the truth–and neither is especially flattering to Medvedev or the Russian government generally–there is no doubt that OPEC feels betrayed. Not that I’m crying or anything, mind you. As I’ve said before, there’s no honor among colluders.

Although some in the Russian government may feel that they’ve played OPEC like a fiddle, the fact of the matter is that Russia is in a world of hurt. (Again, much company in this department, but Russia’s economic straits are more acute than Europe’s or the US’s. Far more acute.) With Urals blend well below $40/bbl again, domestic manufacturing cratering (with the slo-mo devaluation exacerbating the damage), and reserves ebbing, a hard but brittle political system faces an existential challenge. The risks of a cataclysm increase by the day. The probability is not yet 1, but it is rising. And remember that these processes tend to be “jumpy” and exhibit positive feedback–meaning that once the dynamic of protest and repression begins, it often feeds on itself and spins out of control, and does so discontinuously and rapidly.